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Limitations of stabilizing effects of fundamentalists: Facing positive feedback traders

Author

Listed:
  • Baumann, Michael Heinrich
  • Baumann, Michaela
  • Erler, Alexander
Abstract
The authors analyze financial interactions between chartists with bounded leverage and fundamentalists within a heterogeneous agent model, focusing on the role of fundamentalists to stabilize prices. While many related studies are solely based on simulations, the authors analytically prove that the existence of fundamentalists is insufficient to avoid asset price bubbles for a certain setup of a feedback trader model. Moreover, similar studies very often face the criticism that chartists might run out of money before the emergence of bubbles, as these studies typically analyze the role of chartists with unbounded leverage. In the work at hand, however, the authors prove that even in an environment where chartists have limited access to finance, their investment behavior can lead to exploding prices. The chartists under study are so-called positive feedback traders, whose leverage is bounded. Additionally, the authors derive upper boundaries for positive feedback traders' initial investment necessary to avoid exploding prices. In order to stabilize stock/asset markets, intervention measures might be helpful.

Suggested Citation

  • Baumann, Michael Heinrich & Baumann, Michaela & Erler, Alexander, 2019. "Limitations of stabilizing effects of fundamentalists: Facing positive feedback traders," Economics - The Open-Access, Open-Assessment E-Journal (2007-2020), Kiel Institute for the World Economy (IfW Kiel), vol. 13, pages 1-26.
    • Handle: RePEc:zbw:ifweej:201944
    DOI: 10.5018/economics-ejournal.ja.2019-44
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    References listed on IDEAS

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    Cited by:

    1. Michael Heinrich Baumann, 2022. "Beating the market? A mathematical puzzle for market efficiency," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 45(1), pages 279-325, June.

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    More about this item

    Keywords

    heterogeneous agents; feedback trading; fundamentalists; chartists; trend followers; financial bubbles; financial crisis;
    All these keywords.

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • G01 - Financial Economics - - General - - - Financial Crises
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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